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25 Feb 2009 : Column GC117

Grand Committee

Wednesday 25 February 2009

Arrangement of Business

Announcement

3.45 pm

The Deputy Chairman of Committees (Baroness Fookes): Before the Minister speaks to the first statutory instrument, I remind noble Lords that, in the case of each statutory instrument, the Motion before the Committee will be that the Committee do consider the statutory instrument in question. I should perhaps make it clear that the Motion to approve the statutory instrument will be moved in the Chamber in the usual way.

Unit Trusts (Electronic Communications) Order 2009

Copy of the Order
2nd Report from JCSI

Considered in Grand Committee

3.46 pm

Moved By Lord Davies of Oldham

Lord Davies of Oldham: In moving the Unit Trusts (Electronic Communications) Order 2009, I shall also speak to the Open-Ended Investment Companies (Amendment) Regulations 2009.

The Open-Ended Investment Companies (Amendment) Regulations 2009 and the Unit Trusts (Electronic Communications) Order 2009 make provision for the electronic transfer of ownership to units and shares in UK-authorised investment funds. This should permit major efficiency savings and reductions in error rates. I will sketch in some background to these instruments.

The Law of Property Act 1925 in England and Wales and the Statute of Frauds Act of 1695 in Northern Ireland require transfers of title to units and shares in United Kingdom-authorised investment funds to be made in writing. In Scotland, the Requirements of Writing (Scotland) Act 1995 has the same effect for assignments of property made in the form of a gift. Authorised investment funds are collective investment vehicles that are authorised by the Financial Services Authority. They can take the form of open-ended investment companies or authorised unit trusts. The two are very similar, the only significant difference being their legal form. About £400 billion is currently held in these funds.

Although paper processes remain a necessary part of some aspects of the investment fund administration process, they also tend to be more expensive and to have higher error rates than purely electronic processes.

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Indeed, the electronic messaging firm SWIFT estimates that, across the European Union, the additional annual costs generated by using manual rather than fully electronic processes could be as high as €1 billion. When the further costs driven by the higher error rates associated with manual processing are taken into account, this figure could rise to between €5 billion and €10 billion. We therefore believe that the requirements that I have described for a paper-based process in the UK impose significant costs on investment fund managers and their investors.

We estimate that making provision for electronic transfer could bring annual administrative savings for UK fund managers of between £70 million and £290 million. None the less, improvements in efficiency must not come at the expense of maintaining reliable systems that protect the interests of investors. We believe that investor protection will continue to be assured for a number of reasons. First, electronic systems are already a central and reliable part of the financial services architecture. There is, for example, the CREST system for share and bond trading, which holds about 88 per cent of UK shares or, at the retail level, secure systems for internet and telephone banking that are now used significantly by more than 17 million people in the UK. Experience so far has shown that properly designed electronic systems can be equally reliable or, indeed, more reliable than paper-based processes, and that it is right to extend this provision to the fund management industry.

Secondly, under the proposed new rules, the fund manager would retain liability for losses incurred where it acted on instructions that were later shown to have been fraudulent. This mirrors the current position for paper-based instructions and acts to place a strong incentive on fund managers to ensure that they have adequate security procedures in place and to protect investors in the unlikely event of loss through fraud.

Finally, we will require fund managers to take reasonable steps to confirm the identity of the sender of an electronic instruction. For open-ended investment companies, this requirement is contained in the draft instrument. Detailed rules on the operation of authorised unit trusts are included in Financial Services Authority rules, and the new requirement for that type of fund will therefore be imposed in FSA rules. The Investment Management Association has produced guidance for firms on meeting this “reasonable steps” criterion, which it has asked the FSA to approve. The guidance lists the types of electronic communication which can be considered secure and lists precautions which should be taken to verify investors’ identity in particular types of transaction.

The proposals have been the subject of a full consultation. Responses to the consultation supported the principle almost unanimously and included helpful feedback, which we have reflected in the proposals before the Committee today, to ensure the effectiveness in property law of transactions made under the proposed new rules.

In line with the feedback from the consultation, we do not propose to make it a requirement for fund managers to accept electronic instructions. Investment funds are distributed by a wide variety of means—via

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independent financial advisers or other intermediaries, directly by the fund manager or through a platform—and the appropriate means for accepting investor instructions varies accordingly. We therefore want to maintain the flexibility for managers to act only on paper instructions where that is most appropriate. We expect electronic transfer to be taken up quickly for wholesale fund business and to be adopted more gradually in retail markets.

In conclusion, the reforms can bring substantial efficiency savings for the UK fund management industry, and the safeguards they include will ensure that investor protection is in no way compromised. Accordingly, I commend the order to the Committee.

Lord Howard of Rising: I am grateful to the Minister for introducing these two welcome statutory instruments. Indeed, they would have been welcome a year ago. Anyway, he has put forward in his usual fine fashion a number of extremely good reasons for them. It is rather ironic that two instruments allowing for the more efficient and accurate transfer of information should have been held up by inefficiencies and inaccuracies within the Treasury, but such is government.

The statutory instruments are welcome for various reasons which the Minister has already emphasised. The most obvious is that they give the industry the opportunity to make significant savings for a relatively low start-up cost. It is also a good thing that the power is permissive rather than prescriptive. There have been enough fiascos recently around government-contracted IT systems for there to be strong reasons to allow the private sector to go at its own speed. Prescription would not be necessary to achieve a large take-up, as the regulations are both welcome and long awaited by the industry, and are in line with arrangements for other types of financial instruments.

There have been some concerns about the security of the new arrangements, and I am glad to see from the debates in another place on the regulations that liability remains with the fund manager for losses incurred on fraudulent transactions, as it does with paper transactions.

On the whole, the statutory instruments are welcome.

Lord Razzall: I join the noble Lord, Lord Howard of Rising, in welcoming the regulations on the mechanics of transfer of unit trusts and what are called OEICs; I love the way we go into such phrases for these things. There is only one point that I ask the Minister to clarify. It appears from the papers before us that, as the noble Lord, Lord Howard, referred to, one of the consultation outcomes was a separation in regulation between the requirement for a manager to take reasonable steps to verify the identity of the person submitting electronic instructions and the property law provisions providing that a transfer could be effective. In other words, the transfer is effective irrespective of fraud in the transmission of the electronic communication. One important issue here, from the point of view of fund managers, is what the requirement is for managers to take reasonable steps to ensure that the identity of the person submitting the communication has been verified.



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I understand that in another place the suggestion was made that if the regulations of the Investment Management Association were adopted by the FSA, and if the fund manager had complied with those requirements as set out in the recommendations of the Investment Management Association, that would constitute taking reasonable steps and provide a defence for the fund manager in relation to an accusation that reasonable steps had not been taken. I would be grateful if the Minister could confirm that that will be the case.

Lord Davies of Oldham: I am grateful to noble Lords for their constructive response to the order, which brings potential benefits in terms of reducing costs. I want to confirm the obvious point emphasised by the noble Lord, Lord Howard, that liability rests with the manager. It is of course the case, as the noble Lord, Lord Razzall, indicated, that we are concerned that liability remains with the fund manager where there are fraudulent instructions, even if it had taken reasonable steps. There is no doubt where the liability will rest. We have checked that out. As the noble Lord rightly says, the Investment Management Association recognised that the FSA rules will confirm that point.

I stand guilty as charged on the point made by the noble Lord, Lord Howard, about a slight slip with regard to dates on the order which caused an element of delay. Even Homer nods on occasion and on this occasion the Treasury did. I apologise to the Committee for the fairly limited delay that occasioned. He is right to draw attention to government inefficiency on the rare occasions when he finds it.

Lord James of Blackheath: I have a short question for the Minister. When the order came to the Merits Committee, my concern was whether there was any safeguard built into the software for this which would in any way prevent what one might call a run on unit trusts arising from a programme sale knock-on, as occurs in the equity market, and whether you could have an artificially created crisis in the unit trusts as a result of sales by more than one party or another creating a programme sale, knocking on into everyone else who holds those investments at that time to create an unnecessary and unwelcome panic sale on an otherwise reasonable investment portfolio.

Lord Davies of Oldham: I am grateful to the noble Lord. I wish he had asked his question a little earlier, so that I would not be quite so breathless in my response. It is a very important question. He has identified an issue which would cause the gravest concern if we did not think that we were able to guarantee a provision against that. There are provisions for managers to suspend redemptions in the circumstances which the noble Lord has identified, which would certainly be necessary because the consequences could be disastrous in regard to any particular fund. We could suspend.

Motion agreed.



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Open-Ended Investment Companies (Amendment) Regulations 2009

Copy of the Regulation
2nd Report from the JCSI

Considered in Grand Committee

3.58 pm

Moved By Lord Davies of Oldham

Motion agreed.

Mutual Societies (Transfers) Order 2009

Copy of the Order
4th Report from JCSI

Considered in Grand Committee

3.59 pm

Moved By Lord Davies of Oldham

Lord Davies of Oldham: The order has its origins in the Building Societies (Funding) and Mutual Societies (Transfers) Act, which received Royal Assent in 2007. The Act addressed some very important issues and contained three key sections: Section 1 on how building societies are funded, Section 2 on the rights of members in the event of insolvency, and Section 3 on arrangements to facilitate transfers of engagements between different types of mutual organisations. As the Committee will know, the Government laid an implementing order in January this year under Section 3 of the Act, and it is the subject of today’s debate. The first order relates to building societies, and it is significant that the recent merger proposal between the Co-operative and Britannia Building Society cited this order as having made the merger possible.

It is the Government’s intention to lay an implementing order for industrial and provident societies in the near future after further discussions with the sector. However, the Government are not convinced of a case for implementing this in relation to friendly societies as same transfer provisions already apply, whether the transfer of business is to another mutual society or to a company.

The Government welcome this opportunity to update legislation for the mutual sector, and I shall start by explaining why we believe this order merits the support of the Committee. Mutual societies, such as building societies, industrial and provident societies and friendly societies, play a significant role in enhancing financial inclusion and social cohesion and in offering diversity and choice in the financial services sector as well as in contributing to the wider economy. Mutual societies

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continue to excel in their respective sectors. Even in the current tough economic climate, the leading best-buy tables for mortgages are populated by building societies. Child trust funds by friendly societies and, of course, co-operatives continue to lead the way in ethical policies putting the concerns of their members and customers first. I am sure the Committee will recognise the widespread public recognition of the virtues of these societies.

Membership of mutual societies now exceeds 30 million with total assets in excess of £400 billion. They are a significant employer in the UK economy as they employ nearly 1 million people and are the mainstay of many communities. Indeed, the mutual form is now widely acknowledged to be a viable alternative to the proprietary company model.

The Government believe that it is all the more important in today’s global economic climate to have a variety of legal forms of business not only to meet the needs and aspirations of their members but to enhance competition within the economy. Under current legislation, the scope for mutual societies to transfer their business is limited. Usually this means that they are permitted to transfer their business to another mutual of the same category only—for example, from building society to building society. Otherwise, they may transfer to a company and become demutualised, leading to a loss of mutual status and membership.

The order will increase the options available to building societies, allowing them to transfer to a subsidiary of another mutual society under a simplified procedure. This will make it possible to retain the business within a group with a mutual ethos as well as to provide for members of the transferring mutual to have rights in the holding mutual. It contains appropriate safeguards not only to protect the rights of members of the transferring mutual but to prevent demutualisation by the back door. It will enable mutual societies to develop strong group structures as an alternative to demutualisation, which will in turn result in a revitalised and self-sustaining sector offering quality services to its members and enhancing competition in the UK economy.

The order has been drafted after extensive consultation with key stakeholders and interested parties, and we have already seen from the press reports just how exciting the sector considers these proposals in the order. I commend it to the Committee.

Lord Howard of Rising: I thank the Minister for introducing the order. Given that there will have to be shareholder approval before any transfer, we do not object to the order. A number of points were raised in another place, but I shall not waste the time of the Committee by repeating them. They were, on the whole, dealt with by the Minister. However, it would be nice if he could tell the Committee when the order relating to industrial and provident societies will come into effect.

Lord Razzall: We, too, from these Benches, support the order. Perhaps the Minister will elaborate a little on various sections in the Explanatory Memorandum which gives the background to this. First, I am intrigued by paragraph 4.4, which states:

“Following consultation the Treasury does not intend to implement the Act for friendly societies”.



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I was going to ask why. However, I understood the Minister to say that under existing legislation the friendly societies could do what this order sets out for mutual societies. I should be grateful for his confirmation that I understood him correctly.

Secondly, I should welcome a little elaboration about the requirement for urgent implementation of Section 3 of the Act, which of course was the justification for cutting down the consultation period from 12 to eight weeks. Is the Minister saying that this is a result of the current economic climate, or has something not been explained about the urgent implementation?

Thirdly, why do the Government believe, in paragraph 8.5, that there is no need,

I am not sure what “the current economic circumstances” means—

Subject to those questions, I am happy to support the order.

Lord Davies of Oldham: I am grateful to both noble Lords for their response to the order. The noble Lord, Lord Howard, is right: the cardinal principle underpinning the order is that shareholder approval is needed for any such action.

I do not have a date for the industrial and provident societies, but it is our intention to make progress on that provision. I shall write to the noble Lord the moment I have additional information on the timing of that.

The noble Lord, Lord Razzall, asked what is urgent about this. I indicated that the Co-operative and Britannia referred to the order for their merger. He is as well—if not better—versed in economics and business affairs as I am. He will be all too well aware that in the current economic situation mutuals have inevitably been enhanced in the public’s perception as regards the safety of their deposits and their ability and eagerness to negotiate business with them. Therefore, anything we can do to strengthen the mutuals sector at this stage is clearly working with a grain of strong public opinion as to their virtues. We also recognise that in a globalised economy many mutuals can look desperately small. That is not necessarily a disadvantage because they can offer good service to the public. However, in a competitive marketplace the pressure will be for them to have the necessary resources to offer the extensive services they need to offer. Within that framework, therefore, the Government are introducing the order. We think that it is very much in the interests of the nation, on the decision of the shareholders in each case, to facilitate improvements in the sector where these are obviously desirable.

What can one say about the general economic crisis without a diatribe that might last a good several hours and strain the resources of the Committee? I am sure that all noble Lords present would participate in that debate with great alacrity and enthusiasm, but it might not be too appropriate to this measure. However, the noble Lord will appreciate that when we use the phrase “current economic circumstances”, we are careful about

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allowing more wholesale borrowing in the banking sector, given the recent events within it. The building society model has weathered this storm and enhanced its reputation. All well judged perspectives on the current economic situation would say that the mutuals are to be encouraged and facilitated, which this order does.

Motion agreed.

Government Resources and Accounts Act 2000 (Audit of Non-profit-making Companies) Order 2009

Copy of the Order
5th Report from JCSI

Considered in Grand Committee

4.10 pm

Moved By Lord Davies of Oldham

Lord Davies of Oldham: The draft order was laid before the House on 27 January 2009. I hope that it will not detain the Committee too long and that it is not too controversial.

The order is being made under the Government Resources and Accounts Act 2000 and is intended to give the Comptroller and Auditor-General public audit responsibility for 26 non-departmental public body companies and non-departmental subsidiary companies. I am of course grateful for the assistance that we received from the National Audit Office, the various sponsor departments and indeed the companies themselves in preparing these provisions.


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